German hard line on Italy may rebound with Deutsche in crisis

FRANKFURT, Sept 30 Germany's insistence that
Italy accept tough conditions in tackling its problem lenders
may rebound now that Berlin faces a banking crisis of its own.

After months of argument over how to deal with bad debts in
the Italian financial system, Deutsche Bank instead
took centre stage on Friday, with its share price near record
lows and its chief executive trying to reassure staff and
markets that Germany's biggest bank remains robust.

For many in Italy, including Prime Minister Matteo Renzi,
this diverted attention from the country's own difficulties in
recapitalising the likes of Banca Monte dei Paschi di Siena.

Renzi went easy on expressing any Schadenfreude on Friday,
but knocked the ball back into the German court. "We have always
said that the European Union has to do everything in its power
to fix the problems of the banking sector and the main worry
focuses on the German lenders," he told national broadcaster
RAI.

He is not alone. The International Monetary Fund has named
Deutsche as a bigger potential risk to the wider financial
system than any other global bank.

With Monte dei Paschi struggling to persuade investors to
back its third recapitalisation in as many years, Economy
minister Pier Carlo Padoan acknowledged Italy had to get its own
house in order, but not in isolation.

"Just like the problem of bad bank loans must be solved
within a reasonable time frame, so it should be for Deutsche
Bank's problems," he told La Stampa newspaper.

Rome and Berlin have been at odds for months over demands
that Italian savers should shoulder the burden of a rescue of
Monte dei Paschi, Italy's third biggest and oldest bank.

Rome had tried to shield institutional investors and
ordinary Italians who put their savings into the bank's bonds,
while Berlin had wanted them to suffer losses as a condition for
allowing state support.

An official familiar with the German government's stance,
had told Reuters it wanted to prevent Italy tapping European
funds to solve its banking problems, a move that would mean
Berlin footing part of the bill.

Germany points out that while the Italian government is
saddled with heavy debts, citizens' personal savings are high,
meaning private investors should play a role in bank rescues.
"The state is poor," said the official. "The Italians are rich."

Renzi's government opposes such a step, fearing it would be
unpopular before a referendum on constitutional reform in
December.

'SOFTER LINE'

Although Germany is far stronger economically than Italy,
Deutsche Bank's great size poses a greater problem than any
individual Italian lender.

As they prepare for national elections in 2017, politicians
in Berlin also oppose any state bailout of Deutsche, a bank
unpopular among many voters because of its aggressive expansion
on Wall Street that resulted in billions of euros of fines.

The possibility that Deutsche could run short of capital if
it is overwhelmed by penalties puts Berlin in a more vulnerable
position than before, possibly undermining any push for a tough
solution for Italy.

"They have taken a very doctrinaire line with the Italians,"
said Simon Tilford of the Centre for European Reform, a
London-based think tank. "Maybe this gives Germany cover to
soften their line."

While final approval for state aid for banks lies with the
European Commission, Germany's position, as the euro zone's
largest economy, is nonetheless important.

Throughout the euro zone debt crisis, Berlin tried to
insulate its lenders and citizens alike from the problems of
countries such as Greece. This caused ill feeling in states that
were forced into bailouts as well as in some, like Italy, that
did not need one.

Tilford believes that an amicable end to the tensions
between Germany and Italy is now important both for tackling the
banking problems and for the unity of the 19-member euro
currency area.

"What Germany has sought to do since the start of the crisis
is avoid any costs to its banks or taxpayers," he said. "The big
fault line in the euro zone is between Italy and Germany."

Others believe, however, that even the problems at Deutsche
will do little to change Germany, which has lectured other
European countries on how to manage their economies and finances
better throughout the debt crisis.

"Deutsche Bank is embarrassing," said Sven Giegold, a German
member of the European Parliament, adding, however, that he did
not expect Germany to change its general stance. "German
arrogance is more deeply rooted than that."
(Additional reporting by Francesca Piscioneri in Rome; editing
by David Stamp)

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